To say the sub-prime mortgage market is in good health sounds mercenary. What I mean is that the number of people with financial difficulties remains significant and the number of lenders in this market sector continues to rise.
According to analyst Datamonitor, the UK non-standard and sub-prime mortgage markets account for 13 per cent of total gross mortgage advances – worth £31.6bn in 2003.
At the end of 2003, 9.4 million people were classified as non-standard and the biggest part of this pool comprised individuals with county court judgments registered against them, as well as the self-employed.
Unemployment, arrears, possessions and bankrupt-cies have become less important factors, as numbers have fallen during recent years. There were, for example, 1.3 million unemployed people at the end of 2003, down from 1.7 million at the end of 1999.
It is worth clarifying some of the industry's terminology. Sub-prime and impaired credit are terms often used to describe people with a history of credit problems – typically, CCJ, arrears and bankruptcy.
Niche and non-conforming are terms used to describe people who may not have an adverse credit history but whose financial circumstances make it difficult for them to get credit – the self-employed and borrowers with multiple income sources are typical examples.
Some terms, such as non-conforming and non-standard are frequently used to straddle both categories.
The use of terminology is not simply of academic interest. It is important to understand when we are referring to individuals who represent a significantly higher credit risk because they have a history of financial mismanagement – for a variety of reasons including unemployment, divorce, death, as well as people overstretching themselves – and when we are referring to borrowers who may not be able to prove income in the traditional way but may not necessarily represent a higher credit risk.
A number of traditional prime lenders, such as Bristol & West and Britannia Building Society, have entered the non-conforming mortgage markets in recent years, initially targeting lower-risk but higher-margin business in the niche and light-adverse sectors – more terminology for you – before moving down the credit curve to include medium and heavy-adverse credit.
Prime lenders have historically been wary of non-conforming lending but as their margins have continued to come under pressure in their core market, they have moved into these new sectors to bolster profitability.
What is the outlook? Demographically, the predictions are that the size of the non-standard population will decline steadily.
It has already reduced by 600,000 to 9.4 million since 1999 and Datamonitor is predicting a further fall, possibly to as low as 8 million by 2008.
Interestingly, Datamonitor is also predicting that in terms of financial value, the size of the non-standard mortgage market will grow at a faster rate than the prime market, reaching £47.4bn by 2008 and it could even grow to as much as £60bn.
A further £5.2bn can also be added to these figures, which is the estimated worth of the non-standard secured personal loans market. This growth is expected to be fuelled by rising house prices and continued demand for consumer credit – factors which the Government and the Bank of England would both like to see reined in.
Predicting market growth over a four-year horizon is a precarious business, with interest rates, the state of the economy, Government intervention and consumer confidence all major determinants for the final figures.
One thing is certain – lenders are going to continue to see this as a profitable market. Not only are traditional lenders likely to make further inroads, such as Skipton launching Amber Home Loans, but we may also see more new lenders coming into the market. Infinity Mortgages has opened its doors for business this year, initially as a branded lender but with an objective to lend its own money before the end of the year. Freedom Finance has also made the transition from broker to lender, backed by a credit line financed by Barclays Bank.
At the other end of the spectrum, companies such as GMAC-RFC and HBOS, which owns BM Solutions and TMB, will continue to be major forces, with a number of other specialist lenders such as SPML, Mortgages plc and Future occupying the middle ground.
Regulation will have an impact on the market, both in terms of the size of the broker market, which pundits are predicting will reduce in numbers but not necessarily in terms of market share, and in terms of the role of packagers, whose future is looking less clear.
Many big packagers have clearly defined strategies, which involve activities such as becoming authorised principals, providing outsourced third-party packaging services to networks and establishing other distribution channels, for example, direct to consumer).
But many smaller packagers which were quick to exploit a new market opportunity a few years ago have not prepared themselves as well for life in a regulated mortgage market and it is possible that a large percentage may merge, get taken over or fall by the wayside.
Technology will have an impact on the way that brokers operate in this market. Technology is already bringing major changes, speeding up application times, reducing costs and improving information flows.
The higher levels of procuration fees paid for sub-prime business will come under pressure as lenders' margins continue to be squeezed and brokers should not be surprised to see proc fees fall during the next couple of years.
The non-standard mortgage market is changing, but it still represents an important sector for lenders and intermediaries in the future.